Ian Cowie was named Consumer Affairs Journalist of the Year in the
London Press Club Awards 2012. He has been head of personal finance at
Telegraph Media Group since 2008, having been personal finance editor
since 1989. He joined the paper in 1986. He is @iancowie on Twitter.

The Government proposes that, from April 2011, the amount of pension saving each year which will qualify for tax relief will be restricted to an amount in the range of £30,000 to £45,000. This compares with the present annual amount (the Annual Allowance) of £255,000. There is also a possibility that the maximum tax-neutral value of pensions saving at retirement (the Lifetime Allowance) may be reduced from £1.8m to £1.5m.

What were the original proposals?

The previous Government had put in place a complex system to restrict the amount of tax relief for pensions saving, for higher earners, which involved an earnings test, an age-related method of valuing final salary and other defined benefit pensions, and a tapering of tax relief for earnings between £150,000 and £180,000. The net result of this would have been to make any pensions saving unattractive for many higher earners.

How are defined contribution or money purchase schemes affected?

The new proposals are straightforward for individuals who save for pensions through personal pensions or other money purchase schemes, although much more restrictive than the present position. Each year the maximum amount of pensions contributions which can be made by the individual and/or his employer on his behalf, with tax relief, will be restricted to the new Annual Allowance – which will be set somewhere in the range of £30,000 to £45,000. If anyone saves more than that amount, a tax charge at their highest marginal rate will be levied on the excess in that year.

In addition to that, at the time of retirement the total value of an individual’s pensions savings will be tested against the Lifetime Allowance. If, as proposed, this is reduced from its present value of £1.8m, more pensions savers will need to reassess their savings plans so as not to exceed this amount – otherwise tax charges of up to 55 per cent can be incurred on the excess. For example, they might be better off using other tax shelters as welll as pensions; such as individual savings accounts (ISAs).

How are defined benefit or final salary schemes affected?

This is the complicated area. Basically, the amount of new pension accrued each year has to be calculated, and then multiplied by a factor to arrive at a value, which will be tested against the Annual Allowance. Currently, the factor is 10 times, but the Government is proposing to increase this to a factor of somewhere between 15 times and 20 times. If the resulting value exceeds the Annual Allowance, the excess will incur a tax charge at the individual’s highest marginal rate. See the case studies below for more detail son how this may work.

Will it be possible for a pension saver to incur a tax charge as soon as the next tax year, even if they are a long way from drawing their actual pension?

If you make pensions savings through a money purchase plan, be aware of the new Annual Allowance when it is announced, which will not be until late this year. If necessary, change your contribution rates appropriately to stay within this allowance. If your employer contributes to your plan, this may require a negotiation with him to reorganize your remuneration package.

If you are a member of a final salary plan, you should discuss with your employer or pensions manager the likely value of your future pension benefits, and what options can be offered to restructure your remuneration if you are likely to be affected.

What about one-off contributions if I am a bit erratic in terms of putting in large but occasional pension contributions?

Again, you must be aware of the new Annual Allowance. All your pension contributions – your regular contributions, your one-off contributions, and your employer’s contributions – which count towards this.

How much tax am I potentially looking at?

This could amount to several thousand pounds but will depend on your circumstances. Here are some illustrations. All are made on a provisional basis, since we do not yet know what the allowance or valuation factors will be. Our assumptions for the sake of illustration are that the new Annual Allowance will be set at £40,000, the new Lifetime Allowance at £1.5m, and that a factor of 15 times will be used to test final salary benefits against the Annual Allowance.

Pension saver number one

She currently makes regular monthly pensions savings of £1,000, with a matching amount from her employer. In addition, each year she has been making an additional contribution of between £10,000 and £20,000, depending on her annual bonus amount.

Her regular savings are £24,000 a year, and so are not affected by the new proposals. However, if in addition she pays in extra contributions of more than £16,000 in any one year, she will suffer tax charges, and so she should restrict her extra contributions to that amount.

Pension saver number two

Two is a member of a final salary scheme, earning £50,000 a year, and has been in the scheme for 25 years. Scheme benefits build up at one sixtieth of final salary for each year’s service. So, his accrued pension at the start of the year is 25/60 times £50,000, or £20,833 a year. After a normal pay rise, his accrued pension at the end of the year is 26/60 times £52,000, or £22,533 a year. He has therefore increased the value of his pension by £1,700 times 15 or £25,500. This is less than the Annual Allowance, so he is not affected.

Pension saver number three

Three is a member of a final salary scheme, earning £50,000 salary at the start of the year. He is promoted during the year, with a pay rise to £60,000. His accrued pension at the start of the year is 25/60 times £50,000 or £20,833 a year. His accrued pension at the end of the year is 26/60 times £60,000 or £26,000 a year. He has therefore increased the value of his pension by £5,167 times 15 or £77,505. This is more than the Annual Allowance, so he will suffer tax at 40 per cent on £37,505 and face a tax charge of £15,002. In this case, the tax charge will be bigger than his gross salary increase. However, the Government recognises that tax "spikes" may occur for some pension savers, and is seeking views on how to mitigate them. For example, it may allow savers to spread payments of the tax charge over several years.